The decline of oil and gas prices, replacement fuels and Nostradamus

“It’s a puzzlement,” said the King to Anna in “The King and I,” one of my favorite musicals, particularly when Yul Brynner was the King. It is reasonable to assume, in light of the lack of agreement among experts, that the Chief Economic Adviser to President Obama and the head of the Federal Reserve Bank could well copy the King’s frustrated words when asked by the president to interpret the impact that the fall in oil and gasoline prices has on “weaning the nation from oil” and on the U.S. economy. It certainly is a puzzlement!

What we believe now may not be what we know or think we know in even the near future. In this context, experts are sometimes those who opine about economic measurements the day after they happen. When they make predictions or guesses about the behavior and likely cause and effect relationships about the future economy, past experience suggests they risk significant errors and the loss or downgrading of their reputations. As Walter Cronkite used to say, “And that’s the way it is” and will be (my addition).

So here is the way it is and might be:

1. The GDP grew at a healthy rate of 3.5 percent in the third quarter, related in part to increased government spending (mostly military), the reduction of imports (including oil) and the growth of net exports and a modest increase in consumer spending.

2. Gasoline prices per gallon at the pump and per barrel oil prices have trended downward significantly. Gasoline now hovers just below $3 a gallon, the lowest price in four years. Oil prices average around $80 a barrel, decreasing by near 25 percent since June. The decline in prices of both gasoline and oil reflects the glut of oil worldwide, increased U.S. oil production, falling demand for gasoline and oil, and the likely desire of exporting nations (particularly in the Middle East) to protect global market share.

Okay, what do these numbers add up to? I don’t know precisely and neither do many so-called experts. Some have indicated that oil and gas prices at the pump will continue to fall to well under $80 per barrel, generating a decline in the production of new wells because of an increasingly unfavorable balance between costs of drilling and price of gasoline. They don’t see pressure on the demand side coming soon as EU nations and China’s economies either stagnate or slow down considerably and U.S. economic growth stays below 3 percent annually.

Other experts (do you get a diploma for being an expert?), indicate that gas and oil prices will increase soon. They assume increased tension in the Middle East, the continued friction between the West and Russia, the change of heart of the Saudis as well as OPEC concerning support of policies to limit production (from no support at the present time, to support) and a more robust U.S. economy combined with a relaxation of exports as well as improved consumer demand for gasoline,

Nothing, as the old adage suggests, is certain but death and taxes. Knowledge of economic trends and correlations combined with assumptions concerning cause and effect relationships rarely add up to much beyond clairvoyance with respect to predictions. Even Nostradamus had his problems.

If I had to place a bet I would tilt toward gas and oil prices rising again relatively soon, but it is only a tilt and I wouldn’t put a lot of money on the table. I do believe the Saudis and OPEC will move to put a cap on production and try to increase prices in the relatively near future. They plainly need the revenue. They will risk losing market share. Russia’s oil production will move downward because of lack of drilling materials and capital generated by western sanctions. The U.S. economy has shown resilience and growth…perhaps not as robust as we would like, but growth just the same. While current low gas prices may temporarily impede sales of electric cars and replacement fuels, the future for replacement fuels, such as ethanol, in general looks reasonable, if the gap between gas prices and E85 remains over 20 percent  a percentage that will lead to increased use of E85. Estimates of larger cost differentials between electric cars, natural gas and cellulosic-based ethanol based on technological innovations and gasoline suggest an extremely competitive fuel market with larger market shares allocated to gasoline alternatives. This outcome depends on the weakening or end of monopolistic oil company franchise agreements limiting the sale of replacement fuels, capital investment in blenders and infrastructure and cheaper production and distribution costs for replacement fuels. Competition, if my tilt is correct, will offer lower fuel prices to consumers, and probably lend a degree of stability to fuel markets as well as provide a cleaner environment with less greenhouse gas emissions. It will buy time until renewables provide a significant percentage of in-use automobiles and overall demand.

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